HSBC Emerging Markets FX Roadmap – Rally built on shaky foundations
- EM currencies have outperformed, but this has not rested on the soundest of foundations
- US policy risks remain and further signs are needed to suggest the EM reflation story is more sustainable
- We maintain our caution towards EM FX, preferring the INR, IDR, THB, RUB, ARS, ILS and CZK
Inside this edition of the Emerging Markets FX Roadmap…
EM currencies have been rejuvenated since the beginning of the year, but we fear their strength may not be built on the strongest of foundations. USD fatigue has begun to set in, but it is still early days for the new US administration and key policies – particularly on the fiscal front – could soon be announced and propel the USD higher again.
Meanwhile, the data pulse for many EM economies has been more upbeat, drawing portfolio flows back to the region. However, a more prolonged period of improvement is needed to suggest that this is more than just a temporary bounce.
Contrary to recent price action by Emerging Markets FX, we believe a more solid recovery should take place once the new US administration’s USD-positive policies have been fully communicated and EM’s cyclical recovery proves to be sustainable. In the current environment we thus prefer a narrow group of currencies, including those with less exposure to US policy risk, such as the INR, IDR, THB, RUB, ARS, ILS, and CZK.
In Asia, the KRW and the TWD have been the stand-out performers year-to-date. The soft-USD environment has helped, as have the early signs of a recovery in electronic exports, but we have tactically preferred the KRW to the TWD. Meanwhile, February so far has been a busy month for the INR and the latest budget and the Reserve Bank of India (RBI) meeting should be supportive for the currency moving forward. We also look at China’s capital flows and the latest developments in Asian FX policies.
In CEEMEA, the PLN has benefited from the global reflation theme; however, we believe the market may be getting ahead of itself. Elsewhere, we look at the RUB where Russia’s Ministry of Finance (MoF) began FX intervention in February as fiscal buffers improved with higher oil prices. However, we do not see this having a major impact on the RUB’s trend and the currency should remain an outperformer in the region.
In LatAm, we dig deeper into the valuation of the MXN. While the currency does look cheap, its fundamentals have deteriorated notably and do not justify buying the MXN yet. We also take a closer look at the relationship between LatAm FX and US Treasuries, which have been exhibiting a greater connection recently.
The INR should outperform in the region thanks to a more hawkish central bank but also positive reform momentum, which the government made further progress on in the latest budget. The IDR offers similar attributes to the INR but perhaps to a slightly lesser degree due to uncertainties persisting around the recent Jakarta election. Meanwhile, amongst the lower yielding currencies we prefer the KRW in comparison to the TWD. Korea’s tech cycle recovered later than Taiwan’s and so may have stronger momentum in the near term. Korean authorities also appear more concerned about the US administration’s perception of its FX policy than their Taiwanese counterparts.
The worst performer in Asia year-to-date has been the PHP. The currency has faced domestic headwinds, ranging from the recent mining closures to much stronger imports – as the government disburses its budget. Despite this underperformance, we prefer the PHP and its lower beta counterpart – the THB – more than the SGD and the MYR.
We retain a preference for those currencies with stronger fundamental backdrops. Amongst the high yielders, we favour the RUB where domestic growth continues to improve. Despite the MoF’s FX intervention and some signs of overvaluation, the RUB should remain resilient unless there is a notable shift in policy from the central bank (CBR). The TRY and the ZAR have strengthened, despite challenging domestic backdrops – in terms of data disappointment and political uncertainty. We would not chase appreciation in these currencies in light of these challenges.
For the lower yielders, we favour the ILS and the HUF where large external surpluses and strong growth prospects should be supportive. Monetary and FX policy in both economies may be turning less dovish, creating fewer headwinds. We are less positive on the PLN, where the market appears to be overpricing the likelihood of a sustainable reflationary theme, and we are positioned short PLNHUF. For the CZK the focus is on the timing of the exit from the EUR-CZK floor. Expectations are tilted towards May 2017, but the significant rise in FX reserves and apparent long CZK positioning build-up suggest there is a growing risk of an earlier exit, in our view.
Market participants have been taking advantage of the cheap MXN to position themselves tactically on local rates. Nevertheless, the outlook for MXN remains challenging, as returns are less dependent on local factors and more on external risks, while concerns over local politics are coming into focus. We expect the MXN’s outperformance to fade. We recently recommended being long the BRL (which we like from a total return perspective) versus the MXN.
USD-COP has also reached support levels around 2850, and we believe a short-term rebound is due. Colombia’s current account deficit remains high , while financing appears vulnerable, with FDI falling significantly to USD1.96bn in Q3 2016, the lowest amount in seven years. Meanwhile, resilient copper prices have helped keep the CLP relatively firm; however, given that some of the metal’s rally has been motivated by the Chilean mining strike, we think faith in the currency seems misplaced. Finally, Peru’s involvement with Brazilian company Odebrecht has been a negative shock, with Finance Minister Alfredo Thorne saying the government now expects GDP growth to be a full 1pp lower at 3.8% y-o-y.
Full version of HSBC Emerging Markets FX Roadmap and a mix of market analysis from top investment banks are available to our subscribers.
Currency reference table
FX markets performance